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Compensation for private companies: the ins and outs of equity
February 26, 2014
Speakers
Kelley Wall RoseRyan
Kyle Holm Radford
Kelley Wall, Director, RoseRyan Kelley leads the firm’s Technical Accounting Group, which provides technical accounting and SEC expertise to public and private companies on complex accounting matters and implementation of new accounting pronouncements. Kelley also heads up product strategy at RoseRyan, where she defines and charts the future course of their service offerings. Before joining RoseRyan in 2005, Kelley held a number of senior management roles, in areas such as SEC reporting, technical accounting, financial planning and analysis, stock administration, internal controls, worldwide consolidations, mergers and acquisitions and investor relations. Kelley began her career at Price Waterhouse (now PwC), and later returned to PwC’s national office. Kelley is a CPA and holds a BS in accounting from Santa Clara University.
Kyle Holm, Associate Partner, Radford Kyle has over 15 years of compensation consulting experience covering executive, broad-based and Board of Director pay. His work covers all elements of compensation including base salary, annual incentives and long-term incentives. He consults on the design of cash and stock-based compensation programs for a varied range of public and private companies with a focus on high growth organizations in the technology and life sciences sectors. Prior to joining Radford, Kyle held a principal position at Hay Group and was one of the three founders of Presidio Pay Advisors, where he was instrumental in developing their pre-IPO offerings. Kyle has been an instructor for the Northern California Human Resources Association's continuing education program. His work has been published in WorkSpan and he co-authored a chapter on initial public offerings in the recently published Understanding Executive Compensation – A Practical Guide for Decision Makers. He earned a bachelor's degree in finance from Santa Clara University.
Agenda
Equity Compensation Strategies
Equity Compensation Tools
Avoiding Stock Compensation Issues
Key Strategies Prior to a Liquidity Event
Q & A
Equity Compensation Strategies
Start by Identifying Your Stage of Development & Prioritize Accordingly
Consider Creating Systems to Level/
Job Match Employees
First Time Salary and Bonus
Benchmarking
Salary Administration System Development
Annual Bonus Assessment/
Design
Startup
Equity Grant Guideline
Development and Total Dilution Planning
Acquisition Ready
Comprehensive Executive Compensation Review
Peer group selection Compensation Philosophy Total pay Competitiveness
Public Disclosure and Regulatory Preparation Executive
compensation SEC disclosure drafting
Equity plan terms audit and funding needs projections
Tax & regulatory compliance
Executive severance/change-in-control policies and contracts
Board of Directors Compensation Program
Equity Holdings Retention and
Refresh Assessment
Ongoing Cash/Equity Program Review and Incorporation of New
Roles/Incumbents
Equity Award Valuation Assessment for ASC Topic 718 Accounting
IPO Event
Go-Forward Public Company
Compensation Maintenance Go Forward Equity
Strategy (Share Reserves and ESPP)
Radford IPO Compensation Roadmap
Typical Private Firm Typical Public Firm
Peer Group
Usually, no specific identified peer list Focus is placed on comparative
companies similar in size and stage of development
Key metrics include industry, invested capital, revenue, stage of development and employee count
Usually, a specific group of 15 to 20 identified public peer companies
Technology: focus is often on revenue and market cap
Life sciences: focus is often on market cap, R&D spend, product phase/stage
Cash Approach
Base salary must be competitive (no longer getting away with low cash)
Annual bonuses a “definite maybe” these days
Base salary: 50th percentile Annual bonus: 50th percentile or above,
emphasizing the at-risk nature of compensation
Equity Approach
Aggressive award sizes, especially to those risking early entry
Vehicles: Stock options dominate Award sizing metric: Ownership
percentage
50th percentile and up to 75th based on performance
Vehicles: Options, RSUs, performance shares
Award sizing metric: Value
Pay for Performance Egalitarian: “we’re all in this together”
Pay is targeted to key roles and high performers
Private vs. Public Company Pay Philosophies at a Glance
Typical Private Firm Typical Public Firm
Award Sizing Primarily established by targeting
specific ownership percentages; conversion into shares based on TCSO
Primarily established by targeting specific values; conversion into shares is based on stock price
New-Hire vs. Ongoing
Large new-hire grants Ongoing grants delayed until IPO
approaches, or 3-4 years after hire Ongoing guidelines set anywhere from
25% to 33% of new-hire awards
New-hire awards are typically 2x ongoing award sizes
Most employees are eligible for ongoing awards after one year of service
Vehicle Mix
Stock options dominate (A few notable companies used RSUs pre-IPO; however, cash reserves are needed to address taxes)
Mix of stock options and RSUs, with an emphasis on RSUs as the firm matures
Rising prevalence of performance shares for executives
Participation
New hire awards: nearly 100% Ongoing awards: targeted at key
performers and those employees greater than 50% vested (usually 25% to 30% of population at any given time)
New hire awards: participation drops as companies increases in size
Ongoing awards: broad eligibility is maintained, although awards targeted at top performers (usually 40% to 60% of population at any given time)
Private vs. Public Company Equity Practices at a Glance
Parameter Time of
Hire Year 1 Year 2 Year 3+ IPO at $12.00
Equity Grant 400,000 - - 100,000 -
Exercise Price $0.25 - - $6.00 -
Vested Shares - 100,000 200,000 300,000 400,000
Unvested Shares 400,000 300,000 200,000 100,000 100,000
Vested Paper Value N/A—no market until liquidity event
$4.7MM
Unvested Paper Value $600K
A snap-shot of current private company equity models:
Large equity grants are made at the time of hire, typically with 4-year vesting
Refresh grants may occur in year 3 or 4, often set to 25% of new-hire grant levels
Refresh grants are usually offered only to top performers and critical roles (~25% of employees at any given time)
Employees are often very heavily vested by the time of an IPO, creating post-IPO retention concerns
Ask Yourself: Where Are There Retention Gaps?
Equity Compensation Tools
Long-Term Incentive Vehicles Startup
Mid-Cap/ Growth Market
Mid-Cap/ Mature Market
Lg. Cap/ Mature Market Objectives/Implications
Stock Options Only
Provides focus on absolute stock price growth and future upside potential
Restricted Stock or RSUs Only
De-emphasizes stock price growth
Supports employee retention and ownership; especially at slower growth companies
Mix of Options and Restricted Stock or RSUs
Combines stock price growth incentives with greater emphasis on employee retention and ownership
Performance Shares
Allows companies to introduce specific performance-based contingencies into equity awards
Long-Term Cash Requires maturity and cash reserves, and
often the ability to select metrics/set goals over time (e.g., 3 years)
Relative Total Shareholder Return
Reflects institutional investor perspective (portfolio performance)
Maturity of market required for reliable comparator group/index
Emerging Practice Least Common Practice Most Common Practice
The Long March of Equity…
Pros Cons Stock Options No immediate dilution
Employee controls tax event
No retention value for underwater options
Complex valuation
Restricted Stock Ownership in stock
from time of grant No underwater issues
Tax at vesting Higher comp expense
(than option) Immediate dilution
Restricted Stock Units May settle in cash or
shares No underwater issues
Tax at vesting Higher comp expense
(than option) Possible liability
accounting
Performance Awards Goal-based behavior
Shares only issued if performance met
Tracking targets Probability accounting Changing targets =
modification
Pros/Cons Equity Compensation Types
Avoiding Stock Compensation Issues
Cheap stock charges Results from the issuance of private company share-based
payment awards with exercise prices below the fair value of the stock
Typically arises in connection with employee stock options
Potential consequences
Employee tax penalties
Administrative challenges
Higher stock-based compensation expense
Disqualified ISO status
SEC scrutiny during IPO process
Avoiding Cheap Stock Issues
Recommendations Obtain 409A valuations
At least once per year & more often with significant events
Should be contemporaneous
Best when prepared by independent valuation specialist
Document estimates of FV at each major grant date
Limit the number of grant dates in a given year
Tips
Consult your auditors for 409A valuations specialists
Refer to AICPA Practice Aid on valuing private company stock
Obtain 409A at each major grant in the year leading up to IPO
Avoiding Cheap Stock Issues (cont’d)
Caution: Modifications
Modification by definition (ASC 718-20-35-3) A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award.
Recognizing modifications Re-pricings
Exchange of equity awards (e.g. options for RSUs)
Extension of time to exercise post termination
Acceleration of vesting
Change in performance-based metrics
Changes in employment status (e.g. consultant to employee)
Adding “change of control” provisions
Modification implications Additional stock-based compensation expense
Possible tax consequences
Potential loss of ISO status
Tips & Suggestions Understand accounting and tax implications prior to board
approval
Ensure equity software calculation is correct
Document all modification accounting
Caution: Modifications (cont’d)
Key Questions 1. Are awards granted reconciled to board minutes at least once
per quarter?
2. Have all recipients been properly identified in the system and either employee or non-employee?
3. Are employees notified of their awards on a timely basis?
4. Is the paperwork kept in a single location and is it complete?
5. If performance-based awards were granted, who is assessing probability?
6. Has the accounting department been notified of all award modifications?
7. Are taxes withheld for all exercises of non-qualified stock options?
8. What process is in place to ensure that employee terminations are entered into the system promptly?
Priority #1 – Data Integrity
Key Pre-IPO Strategies
Defining your post-IPO equity pool size Evergreen provisions?
Employee Stock Purchase Plans?
Awarding Equity in a Fair and Appropriate Manner as an IPO Approaches
Transitioning Programs and Employees From Private to Public Environments % of Ownership Becomes Value
Stock Options Often Become RSUs
Share Counts Often Decline Award Frequencies Change
Lock-Out Periods and Employee Communication
Plan Administration
Thinking About Pre-IPO Equity Compensation… There’s a lot to Consider
Practice at IPO Technology Life Sciences
New Equity Plan Adoption (% of companies) 90% 97%
Prevalence of Full Plan Evergreen (% of companies) 79% 83%
Median Evergreen Funding Rate (% of post-IPO total common) 4.0% 4.0%
Immediate Funding w/ Evergreen (% of post-IPO total common) 7.5% 6.9%
Immediate Funding w/o Evergreen (% of post-IPO total common) 10.9% 11.2%
Adoption of ESPP Offering (% of companies) 52% 53%
Common Equity Program Modifications at IPO
Source: Radford, 2013 Global Technology and Pre-‐IPO/Venture-‐Backed Surveys
Option-Only Approaches Still Dominate the pre-IPO Landscape
Employee Level
Pre-IPO Technology Public Technology Options
Only RS/RSUs
Only Both Options Only
RS/RSUs Only Both
Executive 94% 1% 5% 12% 45% 43%
Management 94% 1% 5% 15% 70% 15%
Professional 94% 1% 5% 12% 82% 5%
Support 97% 1% 2% 35% 62% 3%
Equity portfolio practices rarely shift until after an IPO
Source: Radford, 2013 Global Technology and Pre-‐IPO/Venture-‐Backed Surveys
Pre-IPO Firms Focus on Time-Based Vesting Ahead of Liquidity Events
Employee Level
Pre-IPO Technology Public Technology Time-Based Vesting
Time + Perf.
Accel.
True Perf.
Vesting
Time-Based Vesting
Time + Perf.
Accel.
True Perf.
Vesting
Executive 100% 0% 0% 88% 12% 28%
Non-Executive 100% 0% 0% 0% 3% 8%
Please note prevalence data may not add up to 100%, as companies may have multiple types of equity awards in place at the same time
Investor pressure, media scrutiny and increased disclosure requirements have forced public companies to improve pay/performance links via true performance contingent vesting – but usually only for executives
Executive Compensation Table
Grant date fair value of equity awards + other compensation
Individual grant details (shares, price, etc.)
Compensation Discussion & Analysis Compensation strategies & philosophies for equity awards
Note: JOBS Act exemption for emerging growth companies
Beneficial ownership table Aggregate of direct and indirect ownership
Significant shareholders (5%+)
Executive officers and board members
Public Disclosure Awareness
Public Disclosure Awareness (cont’d)
Notes to Financial Statements Plan summary/roll-forward
Stock-based compensation information
Details of equity awards by grant date in year prior to IPO
Disclosure of Material Compensatory Arrangements Material compensation plans, contracts or arrangements, or
material amendments and modifications
Four business days to file, unless exception applies
Learn more:
Kyle Holm Associate Partner
Radford
(415)486-7717
Questions?
Kelley Wall Director
RoseRyan
(510)456-3056 x104
Contact us:
Get the report (RoseRyan): www.bitly.com/equitypay
Private to Public Pay planning (Radford) :
https://www.radford.com/home/consulting/ipo_pay_planning.asp
